Fool on Call: Best Buy and Apple Team Up

If this were a boxing match between Best Buy (NYSE: BBY  ) and Circuit City (NYSE: CC  ) , one wonders whether this would be the time to toss in the mercy towel.f

Circuit City got clobbered in the third quarter, as Best Buy continued to take advantage of its superior position. Now the two finish off the round that is fiscal 2007, with Circuit City looking a little more than wobbly, and dizzy from yet another series of blows from the electronics-retailing champ.

If Best Buy's latest quarterly earnings conference call is any indication, the competition, including Circuit City, is about to feel the heat get turned up a notch or two. Like any good boxer, Best Buy is sensing the vulnerability of the weakening competition, and is fully prepared to drop the hammer on them.

An important new partnership showcases Best Buy's intent to go for the knockout. Gleaning insights from the latest call, we will explore the strategy in more detail. 

A partnership forged by customer-centricity
By far the most important observation that came from this conference call was news of the expanded partnership between Best Buy and Apple (Nasdaq: AAPL  ) . The deal is so important on so many levels that I find it a complete mystery that not a single Wall Street analyst explored the topic in more detail during the question-and-answer session of the call.

My astute colleague Ryan Fuhrmann, who noted in a recent take, "Conditions may only become grimmer for the competition, now that two of the best-performing franchises in electronics have decided to join forces," didn't miss the potential impact of the deal. Grim indeed -- I am thinking Grim Reaper grim, not just for other electronics retailers, but for PC manufacturers as well. Yep, you better believe that Hewlett-Packard (NYSE: HPQ  ) , Dell (Nasdaq: DELL  ) , and even mighty Microsoft (Nasdaq: MSFT  ) , find the news more than discomforting, and are doing some serious shifting in their seats.

What's the big deal, you say? Well, on the surface it doesn't look like much of a deal, to be honest. All that we learned from the call is that by fall, Best Buy will have approximately 200 operational Apple store-in-stores. That's it.

But let's look a little closer at the details. Though "200" doesn't leap out at you, it is actually a substantial investment for Best Buy, considering that this represents roughly a quarter of the Best Buy stores in operation to date. Capital expenditures are expected to amount to $800 million to $850 million for the year, and it's a good bet that a good portion of the "improvements in the customer experience" are related to this partnership.

It is on this topic of customer experience that I believe we begin to see the true impact of the partnership. When announcing news of the partnership, Best Buy COO Brian Dunn introduced the topic by stating, "While I'm on the subject of customers (emphasis mine), I would like to take a moment to announce with great pleasure that we'll be expanding our relationship with Apple in 2007." Later, Dunn added that the partnership is "an example of standing up for the customer." And again he points out, "We're still learning the fundamentals of this: the discipline of building everything from the customer back."

The emphasis placed on tying the partnership together with the customer only makes sense if you tuned in to earlier remarks in the call made by CEO Brad Anderson. Here, Anderson talked about the transformation under way at Best Buy and how it understands the meaning of customer centricity.

Anderson took time to talk about the adoption of the traditional view of customer centricity, which took place five years ago by the electronics retailing industry, including Best Buy. From this perspective, retailers would look at an important new product like flat panel HD televisions, and then look at ways they could serve the customer by providing superior sales and services tailored to the product. What Best Buy realized however, is that such an approach doesn't consider "what the customers' needs are and how they're ultimately served by the product."

Today, rather than beginning with a product and trying to serve up a customer, Best Buy begins with the customer, his or her "problems, wants, needs, and desires," and then serves up solutions. Anderson sums it up like this, "Our business broadly defined is about meeting the needs and wants of customers." Well, duh, that's common sense, right? Apparently not -- according to Anderson, the rest of the industry is still signed on to the old understanding of customer centricity.

But it is this new understanding of the term that has led Best Buy to expand its partnership with Apple, providing strong clues of where the customer is at today. If Best Buy is now beginning with what customers are looking for, then we can deduce from this that one of the conclusions drawn from the company's research is that customers want more Apples. Best Buy plans to meet that want and desire by opening up Apple store-in-stores.

A partnership that could transform an industry
Expect the 200 or so Apple store-in-stores to be operational by the fall. We can conclude that expenses related to the store additions will be felt more severely in the first half of the fiscal year. Couple this with another revelation made in the call: that its acquisition of Five Star in China will continue to weigh on profits through the first half of the year. Together, investors can look for "modest declines" in Best Buy's operating income growth rate in the first half of fiscal 2008. In contrast, look for acceleration in the back half that will lead to the company gaining an average of 14% EPS growth for the year.

Apple investors, by the way, should see a continued acceleration of desktop and laptop sales as the year progresses, culminating in a blockbuster holiday season. Ultimately, a year, two, or three years out, once the Best Buy and Apple partnership is fully solidified and Apple computer sales have taken serious chunks of business away from Dell, Hewlett-Packard, and yes, perhaps even Microsoft, look for a transformation to begin taking place among old PC stalwarts. With Apple raising the bar for how we think of personal computing, I expect the competition to respond. One day perhaps, we will see the hip Mac pitted against an equally sharp looking Dell or a stunning Hewlett-Packard. And those who will benefit most are consumers.

So what can electronic retailers like Circuit City do to remain in the competition? My suggestion is for them to get on the horn to Apple as soon as possible and start striking their own deals while tossing out their conventional customer centricity business model.

What are investors to do? For prospective investments in the electronics-retailing segment of the market, keep Best Buy at the top of the food chain.

Best Buy and Dell are Motley Fool Stock Advisor recommendations. Dell and Microsoft are Motley Fool Inside Value selections. Try either service free for 30 days.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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